Basically, analytical procedures consist of evaluations of financial information made by an auditor of plausible and expected relationships among both financial and non-financial data. The analyses can range from simple comparisons (e.g., the current year with the preceding year) to the use of complex models involving many relationships and elements of data (e.g., regression analysis).

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The use of analytical procedures is one method of increasing auditor efficiency. Simple analytical procedures comparisons, ratio analysis, trend analysis, and common size financial statements are effective as attention directing tools in the planning and final review stages of the audit. Those procedures are also effective when used in conjunction with a minimum level of tests of details as a substantive test.

Is that all? Yes, that is how I would describe about analytical procedure. On its implementation, analytical procedure could be uneasy. I believe you knew about that. But let’s see if you can answer 10 questions on the following analytical procedure quiz. Relax, the answers has been provided already, as usually. However, try to not read the answer—use your judgment first. That way, you can do self-assessment.

Before the quiz, here is what the U.S. Statement on Auditing Standards [SAS] No. 56, “Analytical Procedures” says about analytical procedure;

“A basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. Particular conditions that can cause variations in these relationships include, for example, specific unusual transactions or events, accounting changes, business changes, random fluctuations, or misstatements.”

Here is the quiz:

 

1. Which of the following would not be considered an analytical procedure?

a. Estimating payroll expense by multiplying the number of employees by the average hourly wage rate and the total hours worked.

b. Projecting an error rate by comparing the results of a statistical sample with the actual population characteristics.

c. Computing accounts receivable turnover by dividing credit sales by the average net receivables.

d. Developing the expected current year sales based on the sales trend of the prior five years.

Answer: (b)

The requirement is to identify the procedure that would not be considered an analytical procedure. Analytical procedures consist of evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. Answer (b) is correct because projecting an error rate from a statistical sample to an actual population is not a comparison of a plausible relationship. Answers (a), (c), and (d) are all incorrect because they all include a study of plausible relationships.

 

2. An auditor may achieve audit objectives related to particular assertions by,

a. Performing analytical procedures.

b. Adhering to a system of quality control.

c. Preparing auditor working papers.

d. Increasing the level of detection risk.

Answer: (a)

Answer (a) is correct because an auditor may perform analytical procedures to achieve an audit objective related to a particular assertion. Answer (b) is incorrect because a system of quality control provides the CPA firm with reasonable assurance of conforming with professional standards. Answer (c) is incorrect because while working papers provide support for the audit report and aid in the conduct and supervision of the audit, they do not in and of themselves achieve audit objectives (see AU 339 for information on audit working papers). Answer (d) is incorrect because increasing the level of detection risk does not in and of itself achieve audit objectives.

 

3. An entity’s income statements were misstated due to the recording of journal entries that involved debits and credits to an unusual combination of expense and revenue accounts. The auditor most likely could have detected this fraudulent financial reporting by

a. Tracing a sample of journal entries to the general ledger.

b. Evaluating the effectiveness of internal control.

c. Investigating the reconciliations between controlling accounts and subsidiary records.

d. Performing analytical procedures designed to disclose differences from expectations.

Answer: (d)

Answer (d) is correct because an objective of analytical procedures is identification of unusual transactions and events, and amounts, ratios and trends that might indicate misstatements. Answer (a) is incorrect because the limited number of journal entries traced to the general ledger in a sample is unlikely to include the erroneous journal entries. Answer (b) is incorrect because while an evaluation of the effectiveness of internal control might help detect such misstatements, it is somewhat doubtful due to the fact that it is likely that few journal entries are involved. Answer (c) is incorrect because there is no indication that the fraud involves differences between controlling accounts and subsidiary records.

 

4. Auditors try to identify predictable relationships when using analytical procedures. Relationships involving transactions from which of the following accounts most likely would yield the highest level of evidence?

a. Accounts receivable.

b. Interest expense.

c. Accounts payable.

d. Travel and entertainment expense.

Answer: (b)

As higher levels of assurance are desired from analytical procedures, more predictable relationships are required to develop the auditor’s expectation. Relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts, and relationships involving transactions not subject to management discretion are generally more predictable. Answer (b) is correct because interest expense relates to the income statement, and because interest expense is subject to only limited management discretion, given the existence of the related debt. Answers (a) and (c) are incorrect because accounts receivable and accounts payable are balance sheet accounts. Answer (d) is incorrect because travel and entertainment expense is normally subject to management discretion. See AU 329 for more information on the use of analytical procedures.

 

5. Analytical procedures used in the overall review stage of an audit generally include

a. Gathering evidence concerning account balances that have not changed from the prior year.

b. Retesting control procedures that appeared to be ineffective during the assessment of control risk.

c. Considering unusual or unexpected account balances that were not previously identified.

d. Performing tests of transactions to corroborate management’s financial statement assertions.

Answer: (c)

Answer (c) is correct because the overall review stage includes reading the financial statements and notes and considering the adequacy of evidence gathered in response to unusual or unexpected balances. Answer (a) is incorrect because analytical procedures are not particularly aimed at gathering evidence on account balances that have not changed. Answer (b) is incorrect because analytical procedures do not directly test control procedures. Answer (d) is incorrect because tests of transactions to corroborate management’s financial statement assertions are performed when considering internal control and for substantive tests of transactions. See AU 329 for information on analytical procedures and AU 319 for information on tests of controls performed both when considering internal control and as substantive tests.

 

6. Which of the following tends to be most predictable for purposes of analytical procedures applied as substantive tests?

a. Relationships involving balance sheet accounts.

b. Transactions subject to management discretion.

c. Relationships involving income statement accounts.

d. Data subject to audit testing in the prior year.

Answer: (c)

Answer (c) is correct because AU 329 indicates that relationships involving income statement accounts tend to be more predictable than relationships involving only balance sheet accounts. Answer (a) is incorrect because, as indicated, relationships involving income statements are considered more predictable. Answer (b) is incorrect because relationships involving transactions subject to management discretion are often less predictable. For example, management might incur maintenance expense rather than replace plant and equipment, or they may delay advertising expenditures. Answer (d) is incorrect because prior year data is sometimes not a reliable predictor of subsequent year’s data.

 

7. A basic premise underlying the application of analytical procedures is that

a. The study of financial ratios is an acceptable alternative to the investigation of unusual fluctuations.

b. Statistical tests of financial information may lead to the discovery of material misstatements in the financial statements.

c. Plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary.

d. These procedures cannot replace tests of balances and transactions.

Answer: (c)

Answer (c) is correct because, as indicated in AU 329, a basic premise underlying the application of analytical procedures is that plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary. Answer (a) is incorrect because the study of financial ratios is an approach to identifying unusual fluctuations, not an acceptable alternative to investigating them. Answer (b) is incorrect because analytical procedures may be either statistical or nonstatistical. Answer (d) is incorrect because analytical procedures may be used as substantive tests, and may result in modification of the scope of tests of balances and transactions.

 

8. An auditor’s analytical procedures most likely would be facilitated if the entity:

a. Segregates obsolete inventory before the physical inventory count.

b. Uses a standard cost system that produces variance reports.

c. Corrects material weaknesses in internal control before the beginning of the audit.

d. Develops its data from sources solely within the entity.

Answer: (b)

Answer (b) is correct because use of a standard cost system (a form of budgeting) produces variance reports that will allow the auditor to compare the financial information with the standard cost system data to identify unusual fluctuations. See AU 329 for the approach used. Answer (a) is incorrect because segregating obsolete inventory before the inventory count is related to the auditor’s physical inventory observation and will not necessarily affect analytical procedures. Answer (c) is incorrect because correcting a material weakness in internal control before the beginning of the audit generally will have minimal, if any, effect on the historical information used for analytical procedures. Answer (d) is incorrect because data from independent sources outside the entity is more likely to be reliable than purely internal sources.

 

9. Analytical procedures performed in the overall review stage of an audit suggest that several accounts have unexpected relationships. The results of these procedures most likely would indicate that:

a. Irregularities exist among the relevant account balances.

b. Internal control activities are not operating effectively.

c. Additional tests of details are required.

d. The communication with the audit committee should be revised.

Answer: (c)

Answer (c) is correct because when unexpected relationships exist, additional tests of details are generally required to determine whether misstatements exist. Answer (a) is incorrect because irregularities (fraud) may or may not exist. Answer (b) is incorrect because internal control activities may or may not be operating effectively. Answer (d) is incorrect because ordinarily the situation need not be communicated to the audit committee.

 

10. Which of the following comparisons would an auditor most likely make in evaluating an entity’s costs and expenses?

a. The current year’s accounts receivable with the prior year’s accounts receivable.

b. The current year’s payroll expense with the prior year’s payroll expense.

c. The budgeted current year’s sales with the prior year’s sales.

d. The budgeted current year’s warranty expense with the current year’s contingent liabilities.

Answer: (b)

Answer (b) is correct because payroll expense is an income statement expense and because it may be expected to have a relationship with that of the prior year. Answer (a) is incorrect because the accounts receivable account is not a cost or expense. Answer (c) is incorrect because comparing budgeted sales with actual sales of the current year is more likely to be performed than comparing budgeted sales with those of prior years. Answer (d) is in correct because comparing the budgeted current year’s warranty expense with the current year’s contingent liabilities is less direct than that in answer (b), and because one would be more likely to compare current year budgeted warranty expense with actual warranty expense.